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Value versus Growth: Stochastic Dominance Criteria

Value versus Growth: Stochastic Dominance Criteria By Abhay Abhyankar, Keng-Yu Ho, and Huainan Zhao. Comments by Shaojun Zhang Nanyang Technological University. Stochastic dominance (I). Consider two cumulative distribution functions: G and F

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Value versus Growth: Stochastic Dominance Criteria

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  1. Value versus Growth: Stochastic Dominance Criteria By Abhay Abhyankar, Keng-Yu Ho, and Huainan Zhao Comments by Shaojun Zhang Nanyang Technological University

  2. Stochastic dominance (I) • Consider two cumulative distribution functions: G and F • First order stochastic dominance of G over F 1 F(z) G(z) 0 z

  3. Stochastic dominance (II) • Consider two cumulative distribution functions: G and F • Second order stochastic dominance of G over F 1 F(z) G(z) 0 z

  4. Stochastic dominance (III) • Consider two cumulative distribution functions: G and F • Third order stochastic dominance of G over F • SD1 => SD2 => SD3 • If G SD1 F, then median of G > or = median of F. • Or if median of G < median of F, then G cannot SD1 F.

  5. Summary statistics Growth Value

  6. Statistical test • Test I: • Test II: • If Test I fails to reject H0 and Test II rejects H0, then G SD1 F. • If both Test I and Test II fails to reject H0, then G and F have no SD1 relation.

  7. Empirical findings • Value portfolios SD(1,2,3) growth portfolios • 1951-2003 • 1963-1990 • Boom periods in 1951-2003 • Boom periods in 1963-1990 • No SD(1,2,3) relation between value and growth portfolios • Recession periods in 1951-2003 • Recession periods in 1963-1990

  8. Comments • Provide additional evidence on the comparison between value and growth stocks, using stochastic dominance criteria. • Value stocks perform better than growth stocks in boom periods, and as well as growth stocks in recession periods. • Lakonishok, Shleifer and Vishny (1994) shows that value stocks outperform growth stocks in recession periods. • Does not provide conclusive evidence for or against the risk-based explanation of value premium. • Barrett and Donald (2003) assume the observations are independently and identically distributed. Returns on value or growth portfolios are serially correlated. How does the autocorrelation influence the test outcome?

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